U.S. Growth Engine Looks Able to Power Past Stock Market's Woes
(Bloomberg) -- Despite a slump in equities and gains in the dollar, few economists are concerned that broad financial conditions will strangle the second longest U.S. economic expansion on record.
Goldman Sachs Group Inc. has one of the gloomier outlooks and forecasts the the recent decline in equity markets, as well as Federal Reserve interest-rate increases and a stronger greenback, will trim growth by about three-quarters of a percentage point by mid-2019, according to economist Daan Struyven. His outlook assumes stock prices remain steady.
Other economists expressed were not convinced that overall financial conditions had tightened significantly in recent months. And by some measures, including Goldman Sachs’ own index of financial conditions, they are looser now than when the Fed started raising rates in December 2015 in order to rein in the economy.
“The real question is whether the Fed unleashes forces it then loses control of and financial conditions are tightening more substantially than they would have liked,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC in New York. “That doesn’t seem like a huge risk at this stage.”
That may help explain why Fed officials have been slow to express concern over recent stock market woes or the dollar, which has appreciated by more than 3 percent his year. While central bankers say they’re sensitive to sharp movements in financial conditions, their reaction to this months’ decline in equity prices was typified by the muted response from Chicago Fed President Charles Evans.
“So far this all seems modest,” he said on Oct. 12, when the S&P 500 was coming off a six-day losing streak.
The term financial conditions refers to a handful of factors -- typically including equity prices, foreign-exchange values, credit spreads and sometimes commodity prices -- that can influence economic growth. The Fed lowers and raises short-term interest rates in the hope of affecting those conditions and nudging the economy to slow down or speed up. But the transmission is imperfect, and other factors such as fiscal policies or global economic conditions can play a role.
Though the Fed has raised its benchmark rate by two percentage points since December 2015 -- a shift that ought to strengthen the dollar by attracting more capital to the greenback -- the Bloomberg Dollar Spot Index has since declined 2.7 percent. And their recent drop notwithstanding, U.S. stocks have behaved similarly with the S&P 500 returning 41 percent in that period.
That means the dollar and equities are providing more support to economic momentum than they were when the federal funds rate was near zero.
And some components of financial conditions have eased when you look at recent data. For example, the spread of junk bonds over investment grade corporate credit has narrowed about 15 basis points this year.
Detecting a firm signal from financial conditions is also complex because economists and policy makers use a blizzard of models and formulas. While the closely-watched Goldman Sachs index is lower than in 2015, it has increased this year because of its sensitivity to stocks and foreign exchange. Meanwhile a different gauge produced by the Chicago Fed has continued to ease in 2018.
Recent stock moves, given less weight by Chicago, have resulted merely in what economists there termed a “leveling off” of overall financial conditions.
Economists also have any number of individual methods for interpreting fuzzy indicators of future economic activity. Michael Gapen, chief U.S. economist at Barclays Plc, said he likes to separate signs of “financial stress,” like bond spreads and volatility, from longer-term conditions more closely related to monetary policy.
“The latter hasn’t changed much,” Gapen said about longer-term conditions. “Messages from the Fed have been a touch more hawkish lately. The markets have baked in a little more of the Fed’s messaging, and financial conditions have probably tightened a touch.”
Gapen expressed a lingering concern, however, over what will happen when the impact of President Donald Trump’s tax cuts and a burst of federal spending wear off.
“The presence of fiscal stimulus has kept spreads tight and reduced volatility,” he said. “What I worry about is that fiscal stimulus is masking an underlying tightening in monetary policy.”
More reason to monitor a measure of financial conditions. Just choose carefully.
©2018 Bloomberg L.P.